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Debt can have both positive and negative implications on your financial situation. While certain debts, like mortgage debt, can contribute to wealth accumulation and financial freedom, excessive debt can have adverse effects on your finances and credit score.
In today's society, many individuals find themselves overwhelmed by their financial obligations to creditors, making debt a significant issue. If you are among those struggling with debt, a debt management plan could be a helpful solution to regain control. These plans are particularly beneficial for individuals dealing with unsecured loans.
By enrolling in a debt management plan, you can potentially reduce your monthly payments and interest rates. This provides you with an alternative to bankruptcy or default, helping you find a pathway towards financial stability.
How to Set Up a Debt Management Plan?
Set up and managed by a credit counseling company, a debt repayment plan is a type of repayment plan that helps individuals regain control of their finances. By pairing with a credit counselor, you can gain a comprehensive view of your financial situation and better understand the options at your disposal. If you and your counselor feel a debt management plan may be a solution, they can work on your behalf to develop a new payment plan that better fits your budget and lifestyle.
Your credit counselor may negotiate with your creditors to get fees waived and lower your interest rates if you agree to repay your debt using a management plan. A skilled counselor may even be able to get some of your debts reduced. Many debt management plans are structured so individuals can repay their debts within three to five years without having to pay excessive amounts of interest.
Once you enroll in a debt management plan through a credit counseling agency, you will make a single monthly payment to the agency, which will distribute the money to your lenders. It is important to note, however, that you will not be able to manage any collateral-backed loans using a plan. Debt management plans are only for unsecured accounts, such as credit card accounts. Although you will have the freedom to pick and choose which accounts you want to be incorporated into your plan, your counselor may advise you to close certain accounts at some point.
Benefits of Debt Management Plans
If you are struggling with debt, you may find a debt management plan to be a relatively simple solution to a major problem. A plan may be especially helpful if you can’t make minimum monthly payments and your balances continue to balloon. Some of the most important benefits of a debt management plan include:
- Lower payments and waived fees: A counselor can negotiate with your creditors to get your monthly payments and interest rates lowered. This will help you pay off your debt more quickly and efficiently while freeing up money for other expenses.
- Single monthly payment: Instead of multiple statements, you will receive one statement each month and pay a single lump sum instead of multiple payments. This is more convenient and less stressful than juggling multiple payment dates and amounts.
- Quicker debt relief: By paying off principal balances sooner and not having to worry about high interest rates, you can get out of debt quicker.
- Professional guidance: Before you enroll in a debt management plan, a credit counselor will help you better understand your budget, options, and goals so you can pick the best course of action. Many credit counseling agencies offer free consultation sessions, which can be helpful even if you decide to not enroll in a plan.
- Fewer calls: Ducking phone calls from creditors all day can be emotionally exhausting. Once you roll your accounts into a debt management plan, creditor phone calls should stop once all the paperwork is done and everything is approved on both ends.
- Accounts brought current: If you are behind on payments, it can be nearly impossible to pay your entire past-due balance, even if you only have to make minimum monthly payments. Depending on the nature of your plan, creditors may agree to update the status of your account to “current.” This can save you money on late fees.
- Accountability: Instead of struggling to make minimum monthly payments for years, sticking to a debt management plan can free you from debt in a much shorter time. While enrolled in your plan, your credit counselor will hold you accountable for staying on track.
Your counselor may also be able to provide referrals or access to additional financial tools. For example, many credit counseling agencies partner with other agencies that offer homebuying, bankruptcy, student loan, and basic budgeting counseling.
Disadvantages of Debt Management Plans
There are some disadvantages of enrolling in a debt management plan, including the following:
- Enrolling in a plan may affect how much credit you have access to. Your counselor may require you to close your credit cards and avoid applying for new ones while you pay off your debt.
- A debt management plan won’t help you pay off all types of debt. Secured debt, such as a mortgage or car loan can’t be paid off using a plan. You also won’t be able to pay off student loans either. Generally, you will be responsible for managing secured debt payments on your own.
- You may have to pay a small fee to use the services of a credit counseling agency. Many agencies charge an initial setup fee, as well as a monthly fee. Depending on your state’s laws, you may be able to avoid these fees if your financial situation is dire enough.
A debt management plan isn’t always the best solution. In some cases, it may be wiser to take out a debt consolidation loan or transfer a high-interest credit card balance to a lower-interest credit card. If your debt is too significant to be paid off using a plan, you may be advised to declare bankruptcy instead.
Does Enrolling in a Debt Management Plan Impact Your Credit Score?
Although using a debt management plan won’t have a direct impact on your credit score, it may be noted on your credit report. It can also indirectly affect your credit in the following ways:
- Closing accounts can lower your credit score since it increases your utilization ratio. Your credit utilization ratio is the amount of credit you are using in proportion to the amount of credit available to you. In general, using one-third or less of your available credit is recommended if you want a good credit score. It is especially important to note that FICO®, the most widely used credit scoring model, does factor in closed accounts that still have a balance when calculating your score.
- You may have to repay your account balances in full. Although a credit counselor may be able to negotiate lower payments or interest rates, they may not be able to actually lower the amount you owe.
- Your credit score may rise when your accounts are brought current. If your creditors agree to bring your accounts current and you continue to may your payments on time, you may start to notice an increase in your credit score.
It is also important to keep in mind that closed accounts can remain your credit score for up to a decade. Fortunately, closed accounts are only one factor used by credit reporting agencies to calculate your score.